The effect of local political corruption on earnings quality

Our study examines whether political corruption of a local government at judicial district level influences earnings management activities of firms located in a corrupt area. Prior studies suggest that there is an association between political connections and earnings quality (e.g., Braam et al. in Int J Account 50: 111–141, 2015; Harymawan and Nowland in Int J Account Inf Manag 24: 339–356, 2016). Nevertheless, there is little research regarding the impact of local political corruption at judicial district level on financial reporting quality. Using a sample of publicly listed U.S. firms from 2007 to 2014, we find that firms located in corrupt regions are more likely to manage earnings through accruals management and real activities manipulation (i.e., sales manipulation and overproduction). An additional analysis indicates that firms located in corrupt regions have less earnings persistence and are more likely to use positive discretionary accruals to meet or beat the consensus analysts’ earnings forecast. Taken together, our study extends prior literature by addressing the concern regarding the influence of local political corruption on firms’ earnings quality.